Love Affairs: Having one can be taxing!

The Internal Revenue Code provides for the taxation of incomes “from whatever source derived.” But no income taxes are due on gifts. Consequently, the courts are often asked to decide the troublesome issue of whether sizable amounts received by women from acquaintances who were not their husbands are “compensation for services” that should be listed on Form 1040, or gifts that completely escape taxes.

The value of “wifely services”A couple of weeks after Byrnece Green met wealthy Boston businessman Maxwell Richmond, the two became engaged. Ten months later, Richmond begged Green to end the engagement because he had “a mental problem about marriage.” His solution: Sidestep the legal ceremony and just live together. In return for doing that, he promised to leave her “everything.” The arrangement was a good deal for Richmond, as Green was both loyal to the nth degree and savvy. Besides holding down a job as a stockbroker, she did a daily market report on a Boston radio station that he owned and she advised him on his business affairs and investments. Green also monitored his diet, cared for him during illnesses and accompanied him on business trips and to social engagements. She never saw his will, but he assured her that it provided for her. They were inseparable for nine years, until Richmond’s death, which was when she first became aware of a will in which Mr. Right left his entire $7 million estate to his brother and sister.

Green’s understandable response was to sue his estate for the value of services she had rendered to him in reliance on his promise. After a jury trial and appeal, she settled with the estate for $900,000. At tax time, a note explaining that the $900,000 was a nontaxable gift or bequest from Richmond, as all that she had performed were “wifely services,” accompanied her 1040. The reply from the IRS came in the form of a bill for taxes, an assessment upheld by the Tax Court and, on appeal, the Second Circuit Court of Appeals. The Tax Court’s reasoning: “The taxability of the proceeds of a lawsuit depends . . . upon the nature of the claim.” Green based her claim on the value of her services. Hence, the $900,000 clearly was taxable income.

No fair warningSometimes, the feds try to push things too far. For instance, David Kritzik was a wealthy widower in his late 80s when he lavished gifts on his mistresses, Leigh Ann Conley and Lynnette Harris, who were twin sisters as well as Playboy magazine models. Kritzik’s payments to each sister together came to better than $500,000 over the course of several years. His spending habits became known to the IRS, which made its ritual assertion that Kritzik had compensated Conley and Harris for their services, and they owed taxes. But the usual procedure of assessing back taxes, interest charges and civil penalties against the sisters was insufficient for a puritanical IRS. The agency also brought criminal charges against them for willful evasion of their taxes. In criminal trials, both were convicted, sentenced to do time in prison and ordered to pay fines.

No way, said the Seventh Circuit Court of Appeals, which overturned the convictions and ordered that the sisters not be retried on criminal charges for evasion of taxes on money received from Kritzik. The Seventh Circuit ruled that the convictions could not be sustained by testimony from government witnesses to whom Harris described her relationship with Kritzik as “a job” and “just making a living,” her complaint that she “was laying on her back and her sister was getting all the money” and her derogatory statements about sex with him.

Said the appeals court: “The current law on tax treatment of payments to mistresses provided Lynnette no fair warning that her conduct was criminal. . . . A person is entitled to treat cash and property received from a lover as gifts, as long as the relationship consists of something more than specific payments for specific sessions of sex.”